New Idea: Mutual Fund of Credit Union Loans

The NCUA is currently considering amendments to Part 703, the investment regulation. NCUA has not yet issued proposed changes. If you agree that the following idea is worth including in the investment regulation, I ask you to express your support to the NCUA.

Many credit unions are at risk due to the inability to earn sufficient net income to pay the assessments for the share insurance fund and to rebuild capital that was lost due to the corporate credit unions collapse, the real estate crash and the continuing crisis of confidence by consumers. The permissible investment options provide anemic returns. Credit unions have to chase loan yield to survive in the long term. How do credit unions with low loan demand safely earn loan yield?

I have advocated for the NCUA to permit credit unions to buy shares in a registered mutual fund consisting of credit union loans. The mutual fund will consist only of credit union loans and some cash or cash equivalent assets for redemption purposes. The fund will be registered with the SEC. The fund will only buy loans that meet its underwriting criteria. The loans will be underwritten and serviced by credit unions that have passed a vigorous certification process by the fund manager. Certified credit union lenders will demonstrate a high level of lending expertise in the types of loans sold and a successful history of lending. Loan purchases will also have to be approved by the fund manager. The portfolio will be reviewed periodically by a third party for quality control purposes. The portfolio will be reviewed daily by a nationally known company that will provide a daily value of the fund’s assets that will enable the fund to be traded daily. The fund will have channels to sell loans if liquidity is needed or nonperforming loans have to be removed from the fund. The loan documents for loans held in the fund will be stored electronically and accessible remotely by the fund shareholders and regulators. If the fund manager sees a pattern of defaults (geographically, by lender or type of loan) the fund manager can take mitigating steps quickly to stem losses.

Credit unions share loan yield through loan participations where loan-rich credit unions sell loan yield to loan-poor credit unions. The lending risks in a loan are spread between two or more credit unions. Yet the NCUA is wary of the risks of loan participations where the lending problems in one credit union can lead to lending problems in multiple credit unions. I am a big fan of loan participations, but I think the mutual fund concept has notable advantages over loan participations.

There are multiple highly qualified third parties reviewing the quality of the loans purchased in the fund. The buyers of loan participations may or may not have know what they are buying.

The loan performance risks in a fund are spread over hundreds of loans. If a loan defaults in the fund, the fund’s investment performance is marginally affected. If a loan goes bad in a loan participation, credit union assets are lost.

Loan concentration is mitigated much better in the fund. The fund is highly liquid and a loan participation is not. The electronic accessibility of the loan documents and the transparency of the loan performance of hundreds of credit union loans will enable credit unions and the regulators with a highly efficient means to judge and manage risk. The fund gives both credit unions and regulators the ability to see loans on a systemwide basis, spot problems sooner and react to problems proactively. The fund is overseen by the SEC with all of its investor protection provisions of disclosure and transparency.

We have determined that the expenses will be limited to 150 basis points. The question is whether all of the above advantages are worth the cost. In the end, the marketplace will determine the success of such mutual funds. If a fund performs well and gives good value, credit unions will buy and hold shares. If a fund does not perform well, it will be easily detected and avoided. The key is having a fund that is liquid so credit unions can quickly and effectively react to problems.

The Federal Credit Union Act enables credit unions to buy shares in a registered mutual fund consisting of credit union loans. The NCUA approved a pilot program in 2005 (now discontinued by the participants) that permitted credit unions to buy shares in an unregistered mutual fund consisting of member business loans. The NCUA has recently confirmed that credit union may sell loans to a mutual fund but has not confirmed that credit unions may buy shares from such a mutual fund. What is more appropriate for credit unions to invest in than credit union loans? We say we need to innovate to succeed and innovation requires the willingness to try something different.

If you believe that credit unions should be given a chance to buy shares in a registered mutual fund consisting of CU loans, write to the NCUA. Express your opinion in your own words or enclose this article with your endorsement. Now is the time as the NCUA considers amendments to its investment regulation.